‘Opportunity Zones’ Potential Windfall for Developers, Investors

The Trump administration in October released its first set of proposed rules for a new tax incentive that’s intended to bring economic development and jobs to selected low-income communities across the country. Called “Opportunity Zones,” they are part of the “Tax Cuts and Jobs Act” signed by President Donald Trump in December 2017.

Opportunity Zones will create an archipelago of domestic tax havens intended to spur economic activity through private investment. Governors of every state designated a quarter of eligible low-income census tracts as Opportunity Zones and then the Treasury Department approved 8,761 zones across the country: Most are in urban areas along with almost all of Puerto Rico.

Treasury Secretary Steven Mnuchin said he “couldn’t be more excited” about the program, adding that he expects over a $100 billion to be invested. Senator Cory Booker (D-NJ), who co-sponsored earlier legislation to create Opportunity Zones, described the tax incentive as the “single biggest economic development program we’ve seen in a generation,” citing the need for capital in struggling communities like Camden and Newark in his home state.

Nationwide, some of the areas selected as opportunity zones haven’t seen investment in years, but others have. Some include university campuses, military bases, and even a Trump golf club.

“The selection of the zones was not always well targeted to need or purpose,” said Brett Theodos, principal research associate with the Urban Institute. He analyzed the zones based on the current level of private investment and socioeconomic change.

In New York City, there are 306 zones which represent 60 percent of the state total. The list was developed by the Empire State Development Corporation, and then submitted to Governor Andrew Cuomo for approval. The zones were selected with input from city and state agencies responsible for economic development and affordable housing, according to Pravina Raghavan, executive vice president of Empire State. Eric Clement, senior vice president at NYC’s Economic Development Corporation, said it recommended areas based on an assessment of both “need and growth potential,” adding that the agency was  “very pleased” with the final designations of the zones.

They include impoverished neighborhoods like parts of the South Bronx and Brownsville, but also communities that have already seen a lot of redevelopment like the Brooklyn Navy Yard, Long Island City, and Downtown Brooklyn. There’s also some overlap with Mayor Bill de Blasio’s recent rezoning proposals and neighborhoods across the boroughs that are already gentrifying.

Big win for real estate

From the start, Opportunity Zones were seen as being weighted towards investments in real estate.

“The people best positioned to take advantage of this program are developers who are already working in these communities and have projects that are fairly far along,” said Seth Pinsky, executive vice president of RXR Realty, at an investment conference organized by the NYCEDC in September.

The latest rules “considerably expand opportunities for real estate investors,” recent analysis from the Urban-Brookings Tax Policy Center found. Already, investment firms, law firms, and developers are racing to set up “Opportunity Funds” to take advantage of the new program.

The idea is to use tax-breaks to incentivize wealthy Americans who have substantial capital gains to invest some of those profits in poor communities. For example, if investors keep profits subject to capital gains in Opportunity Funds for seven years, their taxes will be reduced by 15 percent. As long as their money remains in the funds, they can delay paying those taxes until 2026.

There is an additional tax benefit as well. The Opportunity Funds can invest in businesses like real estate developments or start-ups. If those investments make a profit and the investor keeps their money in the fund for ten years, those profits will be entirely tax-free.

“This is where I’ve literally watched people drop their glass, look at me, and go, ‘Are you serious?’” Booker said at an investor event this summer with New Jersey Governor Phil Murphy.

Additionally, the proposed rules do not require that all the money in a fund be spent in an Opportunity Zone: A little over a third of the fund (37 percent) can be invested outside the zones.

This tax-break is expected to be used by small group of individuals as only 6.5 percent of Americans are expected to pay capital gains taxes this year according to the Tax Policy Center. That said, Opportunity Zone proponents estimate that there’s potentially more than $6 trillion of unrealized capital gains that could flow into the program. Goldman Sachs, online real estate investing platform Fundrise, investment firms and even some developers have already set up Opportunity Funds in anticipation of the new program.

Many tax specialists who have analyzed the rules say a majority of the investments will go to real estate development: Projects that qualify include new construction as well as those that include “substantial improvement” to an existing building in one of the zones. Already, sales of development sites in Opportunity Zones have jumped 80 percent compared to last year, according to data cited in the Wall Street Journal. Property prices have also been rising by as much as 50 percent in some zones. Tax lawyer David Miller from Proskauer Rose tweeted that one of his clients called Opportunity Zones “the greatest thing for real estate in, like, the last hundred years.”

President Trump and his son-in-law and senior advisor Jared Kushner might also benefit from the new program. The Trump National Golf Club Philadelphia is located in an Opportunity Zone in Pine Hill, New Jersey. Golf courses do not qualify for the investments under the new tax benefit because they are considered “sin businesses,” and not permitted. Some tax lawyers, however, believe there could be a workaround due to different rules for what Opportunity Funds can own and operate and what businesses in the zones that receive funds are allowed to do. The president has not divested from his company and can still profit from it.

As for Kushner Companies, it has least ten properties in Opportunity Zones, including three in Long Branch, New Jersey, purchased in May and August of 2018. The Treasury Department certified New Jersey’s designated zones in April. Jared Kushner has not fully divested from his family's real estate business. Neither the Trump Organization nor Kushner Companies responded to request for comment.

No protections for local communities

The idea of tax-advantaged zones dates back to Margaret Thatcher and Ronald Reagan who promoted Enterprise Zones as a way to reduce urban poverty by driving private investment through tax breaks. Studies have shown, however, that these zones had a negligible impact on reducing poverty. Nevertheless, support for the concept has only grown over the years.

This latest version is credited to Silicon Valley billionaire and Napster founder Sean Parker and a bipartisan group of senators, South Carolina Republican Tim Scott and New Jersey Democrat Cory Booker.

“Creating these zones is a tremendously inefficient way of tackling inequality because opportunity funds will drive investments in profitable enterprises, not to help people living in poor areas,” said Timothy Weaver, assistant professor of political science at the State University of New York at Albany and the author of a recent book on enterprise zones.

Tax policy analysts also argue the costs of Opportunity Zones might outweigh the benefits. Congress estimated a net revenue loss to the IRS of $1.6 billion over ten years, assuming the deferred tax payments are eventually collected. The proposed rules could increase that amount substantially, particularly if tens of billions of dollars are invested in the funds. Describing tax laws as “crude instruments” to achieve social and economic goals, Steve Rosenthal, senior fellow at the Tax Policy Center said, “Investors are more interested in nice returns and not the social impact.”

Neither the law nor the proposed rules include any conditions that would require investors to ensure that residents in the zones benefit from the investments; that responsibility is left to local governments and investors.

“How that capital flows into the zones will make the core difference between actually addressing economic inequality and being a washing machine for people’s capital gains,” said Aaron Seybert, social investment officer at the Kresge Foundation.

With large sections of the South Bronx now designated as Opportunity Zones and a ten-fold increase in land purchases in the zones this year, City Council Member Ritchie Torres said he hoped the investments would not end up displacing the underserved communities who live there. “Having the pendulum swing from redlining to gentrification is hardly progress,” he said.

Clement with the city’s economic development agency said it is well-aware of the potential risk of gentrification and that city officials are currently working with nonprofits and foundations to develop guidelines around affordability and other metrics.

The Treasury Department is expected to finalize the rules for Opportunity Zones early next year.